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U.S. Securities and Exchange Commission

Roundtable on Proxy Voting Mechanics

Topic One: Share Ownership and Voting

The vast majority of publicly traded shares in the United States are held in “street name.”

Background: In the United States, most investors’ holdings of stock are not matched with particular shares of stock. Instead, investors hold their shares through brokers, and thus have an interest in a pool of shares. Approximately 85% of exchange-traded securities are held by securities intermediaries, such as broker-dealers and banks, on behalf of themselves or their customers. The vast majority of these securities are deposited with The Depository Trust Company (DTC), a Commission-registered clearing agency acting as a securities depository, and held in fungible bulk for the benefit of DTC participants. As a result, broker-dealer participants of DTC own a pro rata interest in the aggregate number of shares of an issue held by DTC, and their beneficial owners (i.e., the broker-dealers’ customers) own an interest in the shares in which their broker-dealers have an interest. Consequently there are no specific shares directly owned by either the broker-dealer participants or the underlying beneficial owner.

Although brokers do not match customers’ holdings with particular shares of stock, they maintain books and records to record investors’ interests. Broker-dealers must track all trades and other movements in all customer accounts. Broker-dealers also record for each security total long and short positions for the broker and its customers, and the location of these securities. For customers holding securities through cash accounts or without margin loans, broker-dealers must have possession and control of their securities.

What is the procedure by which beneficial owners vote? Are beneficial owners informed of the voting procedures?

Background: As the record holder of the vast majority of securities held in street name, DTC receives a proxy from the issuer reflecting its ownership on the record date, and passes the proxy on to its participants based on the number of shares the participant has with DTC.

Most broker-dealers outsource proxy processing functions, including forwarding proxy materials to beneficial owners and collecting voting information from beneficial owners for forwarding to the issuer. Broker-dealers electronically send to their service provider the names and addresses of those beneficial owners on their records that are eligible to vote. The service provider in turn distributes the proxy materials (referred to as voter instruction forms or VIFs) to the beneficial owners.

If broker-dealers have lent customers margin securities, or have not received all the shares that they have purchased for customers, broker-dealers may not have the right to vote as many shares as their customers own. In these cases, broker-dealers use differing methods to distribute votes among their customers. Some send a VIF to all customers holding a securities position in that issue, because many customers do not respond. Others allocate the aggregate number of shares the firm is permitted to vote among their customer base, generally allocating a vote first to cash accounts, then fully-paid customers and next to the margin customers, provided there are any remaining shares, and then send out VIFs. (See the discussion below regarding reconciliation for more detail allocation methods.)

In addition to the distribution of VIFs to their customers, a majority of broker-dealers contract with a service provider to tabulate votes cast by the broker-dealer and by their customers. As votes are submitted, the service provider compares the aggregate number of shares held in the broker-dealer’s DTC account plus any other shares the broker-dealer may have (e.g., those held in certificated form or at foreign depositories, etc.) with the number of votes actually cast. If the number of votes cast exceeds this aggregate number of shares, the broker-dealer will instruct the service provider how to reconcile the number of votes to be cast to the number of votes the broker-dealer is entitled to cast. On the day of the meeting, the service provider, in coordination with the broker-dealer, performs a final reconciliation and casts the official vote with the issuer.

Generally, beneficial owners can use one of three methods to instruct the broker-dealer or service provider how they wish to cast their vote: (1) physically marking the VIF and returning it to the broker-dealer or service provider; (2) calling a toll-free number provided by the service provider specified on the VIF and using a control number identified on the VIF; or (3) accessing a website provided by the service provider and using a control number identified on the VIF.

How can proxy under-voting and over-voting occur? How often and to what extent do they occur?

Background: Over-voting occurs when a broker-dealer casts more votes on behalf of itself and its customers than it holds at DTC. This may occur for a number of reasons. One reason is the failure to deliver securities.

When a customer buys a security, the broker-dealer typically credits the customer’s account with the security on the settlement date. However, if another broker-dealer has failed to deliver that security to the clearance and settlement system, the broker-dealer may not have received those securities in its account at DTC. Unless the broker-dealer reconciles the imbalance in some manner, the broker-dealer may over-vote.

Securities transactions in the U.S. are generally cleared and settled on a net basis at the National Securities Clearing Corporation (NSCC) and held in fungible bulk at DTC. While delivery of securities to NSCC usually occurs as expected, there are times when broker-dealers will fail to deliver securities on a timely basis. This can occur for a variety of reasons, including events that are out of the broker-dealer’s control, such as delays in obtaining transfer of title, the inability to borrow securities in time for settlement, or the failure to receive securities.

In the course of netting securities, NSCC replaces the original parties to a transaction, which frees it from tracking these original counterparties. If a seller does not deliver the securities owed, NSCC will allocate the resulting failure to receive among the broker-dealers holding the security at NSCC, not necessarily to the original counterparty. As a result, the broker-dealer that has the failure allocated to it may not have as many shares in its NSCC account as customers with an interest in the securities.

Over-voting can also occur when broker-dealers lend stock. A broker-dealer is permitted to loan securities in customers’ margin accounts as a means to finance the margin loans, unless a customer has fully paid for its securities. The standard stock loan agreement transfers the right to vote proxies to the borrower. If the broker-dealer has loaned shares in that stock, some margin customers’ right to vote their securities may have been transferred to the borrower.

The broker-dealer holds all its shares in fungible bulk, so it does not match loaned shares with any particular margin customer. If the broker-dealer provides all of its margin customers with a VIF, and all of these customers submit voting instructions, the broker-dealer will not have sufficient instructions to vote its proxies. If the broker-dealer sends all of its proxies to the issuer without reducing and allocating the instructions to reflect the loaned stock, the broker-dealer can over-vote.

Most broker-dealers take the position that the practical reality of any imbalance is relatively small for purposes of voting because only a small percentage of their retail customers actually vote. (Broker-dealers estimate retail voting rate averages 30 to 40 percent.) Normally, any potential for an over-vote would be compensated by the “under-vote.” An under-vote occurs when the broker-dealer allocates a vote to customers and some of those allocated a vote do not vote. The failure to vote by these customers may result in the issuer not obtaining quorum. Critics of the current proxy voting system believe the over-vote is an indicator that in fact broker-dealers are failing to make determinations as to which of their customers are actually entitled to a vote and to ensure that only those customers entitled to vote receive a vote. However, others contend that to force broker-dealers to make those determinations may result in an under-vote and no quorum.

How can these issues be addressed, and at what cost or consequence?

Background: Generally broker-dealers attempt to address the over-vote/under-vote situation by implementing of one of three reconciliation methods: (1) “post-mailing reconciliation”; (2) “pre-mailing reconciliation”; or (3) a hybrid process of both post-mailing and pre-mailing reconciliation.

Post-mailing reconciliation (post-reconciliation) is a process whereby the data is reconciled to accommodate an over-vote situation after the broker-dealer’s customers have submitted their votes. If the broker-dealer votes in excess of its position at DTC, the broker-dealer will reconcile or adjust the number of votes to correspond to its DTC position. The manner in which the adjustment is made varies among firms. Some simply reduce the number of votes cast by the firm’s proprietary position. Others use formulas whereby they may allocate only a certain number of votes or a certain percentage of the broker-dealer’s overall position to customers with securities purchased on margin. Others use a lottery system.

Pre-mailing reconciliation process (pre-reconciliation) is a process whereby the broker-dealer determines which investors are entitled to vote and adjust their stock records prior to sending the proxies to their customers. Although firms use various criteria to make these adjustments as to which customers are entitled to vote, many firms adjust their records to reflect securities on loan. Customers with fully-paid securities are given first priority and allocated a vote. To allocate any remaining votes among their margin account customers, the firms generally use a lottery or pro rata method.

Finally, some broker-dealers have developed hybrid reconciliation or allocation methods that use aspects of both pre- and post-reconciliation methods. For example, one broker-dealer may allocate votes to its customers with fully paid securities but also allow each margin account customer to notify the broker-dealer that it would like to vote its shares. The broker-dealer will allocate the remaining shares to those margin customers who indicated they wanted to vote, giving these margin customers priority over other margin customers.

A broker-dealer’s adoption of a particular allocation or reconciliation process is generally based on the type of business the broker-dealer conducts (e.g., retail, high net worth clients, or institutional) and its philosophy as to which beneficial owners should be entitled to vote in the event of an imbalance. Some firms using post-reconciliation believe that this method allows more beneficial owners to vote (because the broker-dealer does not decrease the votes of its margin account customers unless it has to do so) and reduces the problems associated with under-voting and reaching quorum. They contend that the number of over-vote situations is not a significant problem and can generally be addressed by using the firm’s proprietary positions to cover the imbalance. The cost associated with post-reconciliation is generally considered to be less than the costs associated with pre-reconciliation. Broker-dealers that are primarily retail-based appear to support post-reconciliation more than those firms with primarily institutional clients. The critics of post-reconciliation contend that post-reconciliation does not sufficiently disclose to customers that they may not be able to vote all the shares they have purchased or that the votes they cast may not ultimately be sent to the issuer. If there is an over-vote, the broker-dealer will have to decrease the customers’ vote but the customers will never know some or all of their votes did not count.

Those firms using pre-reconciliation believe that this method appropriately allocates votes among its customer base, provides additional transparency by informing customers how many shares they may vote, and better ensures that the votes cast pursuant to the VIF be submitted to the issuer. These firms have also indicated that pre-reconciliation is relatively more expensive than post-reconciliation. Firms using pre-reconciliation tend to have more institutional customers than retail customers. Critics of pre-reconciliation believe that this method does not maximize retail customers’ ability to vote because some customers will not get the opportunity to vote even though their broker-dealers have a sufficient number of votes resulting from other customers who do not vote.

Topic Two: Broker Proxy Voting

What is the impact of broker proxy voting on elections of directors? Should broker voting be eliminated for uncontested director elections, consistent with the recommendation of the NYSE Proxy Working Group?

Background: Currently, the vast majority of investors own their securities as beneficial owners through, and in the name of, one or more securities intermediaries such as a broker-dealer or bank. This is referred to as “street name” ownership because the holder of record is considered to be the intermediary (e.g., broker-dealer) for purposes of voting shares and the investor is the beneficial holder. It has been estimated that as much as 85% of exchange-traded securities are held in street name.

Under NYSE Rule 452, a broker is entitled to vote on certain “routine” matters if the beneficial owner of the stock has not provided specific voting instructions to the broker at least 10 days before a scheduled meeting. NYSE determines whether a matter is routine or non-routine, and broker-dealers are not permitted to vote on any contested matter or any matter which may affect substantively the rights or privileges of the stock. NYSE Rule 452 sets forth 18 non-routine matters. Broker votes of uninstructed shares help issuers meet quorum at shareholder meetings since many beneficial owners do not regularly vote their shares.

The NYSE has historically treated the uncontested election of an issuer’s board of directors as a routine matter and eligible for broker voting. Over the past few years, the NYSE has had to make increasingly controversial determinations as to what constituted a “contest” and therefore not to permit the broker vote. For example, the NYSE has determined that “just vote no” or “withhold vote” campaigns, when there is no opposing director, are routine matters. This has caused some concern by investor and institutional groups.

In connection with these interpretive issues, and recent developments of shareholder activism and changes in the proxy voting process, the NYSE formed a working group in April 2005 to review and make recommendations on its proxy voting rules. In June 2006, after hearing presentations from various parties, the NYSE Proxy Working Group (Working Group) recommended, among other things, that NYSE add the uncontested election of directors as a non-routine matter in Rule 452 and thereby eliminate broker discretionary voting with respect to all elections of directors. The NYSE supported this change and, on October 24, 2006, filed a proposal to eliminate broker discretionary voting on all elections of directors (contested and uncontested) for shareholder meetings held on or after January 1, 2008. This proposal has been filed with the Commission. Some market participants have claimed the proposal, if approved, would be unduly burdensome and particularly costly to investment companies and smaller issuers, as discussed below.

Would the elimination of broker voting on uncontested director elections place disproportionate burdens on certain types of issuers, such as investment companies or small issuers?

Background: The NYSE Proxy Working Group recognized that its recommendation would affect issuers, but determined that the election of directors, even if uncontested, is not a routine event in the life of a corporation. The Working Group recognized that its recommendation would also likely increase the costs of uncontested elections, as issuers would have to spend more money and effort to reach shareholders who do not routinely vote. The Working Group noted that soliciting additional votes under the current system of shareholder communications is likely to be a time consuming and expensive process, as approximately 75% of beneficial owners today are objecting beneficial owners (OBOs), which prohibit the issuers from directly contacting them. The Working Group found that many investors did not understand the voting process and the distinction between OBOs and non-objecting beneficial owners (NOBOs) and believes that with more education more investors would opt to be NOBOs, which could help address the access issue and costs associated with soliciting proxies.

Various entities, including the Investment Company Institute (ICI), have commented on the NYSE’s proposal. The Investment Company Institute has requested that mutual funds and closed-end funds be excluded from the proposed rule because most funds would not be able to meet state law quorum requirements for holding an annual meeting without the broker vote on uncontested elections of directors, due to the funds’ large percentage of retail investors who historically do not vote on the election of directors. Further, the Investment Company Institute noted that mutual funds are different than operating companies, as mutual funds are regulated entities under the Investment Company Act of 1940 and, unlike operating companies, mutual funds generally do not have any other uncontested matter on their ballot that could help them achieve quorum. For example, most operating companies have the ratification of independent auditors on their ballot, which is considered a routine matter and helps the issuer achieve quorum for its shareholder meeting, while most mutual funds have only the uncontested election of directors on their ballot.

What are the relative strengths and weaknesses of proportional voting? How is the proportional voting experiment working out in the 2007 proxy season?

Background: Under proportional voting, brokers vote uninstructed shares in the same proportion as instructed shares. Although the Working Group considered proportional voting on all matters, including non-routine matters, they did not observe any current problems in issuers meeting quorum requirements on non-routine, contested matters where the broker vote is not permitted.

Proportional voting could be tabulated in different ways: vote the uninstructed shares in proportion (1) to all shares cast (all votes), (2) to only beneficial owners who provide instructions (beneficial vote only), or (3) to the retail portion of the beneficial owners who provide instruction (retail vote only). In addition, proportional voting could be tied to voting on an individual broker level (broker-by-broker) or the aggregate voting of all brokers (all brokers). There is concern that calculating the vote on a broker-by-broker basis, while easier to implement than on an aggregate basis, could skew the results depending on the broker’s client base.

Proportional voting could be desirable for issuers since brokers could vote uninstructed shares. However, proportional voting would continue to assign votes to uninstructed shares. In addition, proportional voting would increase the influence of shareholders who vote since an actual vote will affect the voting of uninstructed shares.

The Securities Industry and Financial Markets Association recently encouraged its members to consider voting uninstructed retail shares in proportion to the voting instructions each broker receives from its retail clients. The Securities Industry and Financial Markets Association believes that proportional voting on routine matters is a more appropriate method of reflecting the intent of the broker’s clients than a blanket vote for management. Some broker-dealers have recently adopted the proportional voting approach and intend to vote uninstructed shares on routine matters in proportion to the actual instructed retail vote they receive in the 2007 proxy season.

In addition to proportional voting, client-directed voting has been discussed, which would allow beneficial owners to direct the broker to vote shares in the client-directed manner in those elections in which the shareholder fails to provide election-specific instructions. Under client-directed voting, beneficial owners would make their voting decisions at the time they sign their brokerage agreements. Client-directed voting may raise concerns because the client (beneficial owner) is being asked to make a voting decision prior to receiving any proxy materials.

Topic Three: Shareholder Communications

Do issuers have adequate means to communicate with their beneficial owners? Would the use of an Electronic Shareholder Forum, with its guarantee of anonymous participation only by registered security holders, offer a better alternative than the current system?

Background: The Commission’s shareholder communications rules, Exchange Act Rules 14a-13, 14b-1 and 14b-2, were established more than 20 years ago following recommendations from the Commission’s Advisory Committee on Shareholder Communications. These rules, which were adopted to implement the requirements in Exchange Act Section 14(b), set forth the process by which proxy materials are distributed by issuers to the “street name” holders of their shares. Currently, approximately 85% of exchange-traded securities are held in street name, which is a substantially higher percentage than when the shareholder communications rules were first adopted. Some issuers believe that the existing system is too cumbersome and expensive because issuers must communicate with their beneficial owners through the intermediaries holding the shares in street name rather than communicating with the beneficial owners directly. Many issuers object to the fact that it is the intermediaries, rather than the issuers, who choose the agent through which proxy materials are distributed, even though the issuers are responsible for the expense of that proxy distribution. These issuers also believe that more effective communications could be achieved by revising the shareholder communications rules to allow issuers to communicate directly with beneficial owners.

Various industry participants believe that technological advances since the adoption of the shareholder communications rules have made direct communications with beneficial owners more feasible and potentially less expensive, thereby enhancing the potential for more effective communication among shareholders and management and, ultimately, providing an opportunity for improved corporate governance. The recent amendments to the federal proxy rules allowing for the Internet availability of proxy materials are an example of the use of technological advances in furtherance of communications between issuers and shareholders. Other industry participants, including many broker and bank intermediaries, believe that the current system was established based on the consensus of interested industry participants and continues to work well.

Should beneficial owners continue to have the ability to object to having their names disclosed? Should issuers have access to the list of beneficial owners who do not object to having their names disclosed for use in distributing proxy materials and consent solicitations to beneficial owners? If so, should other shareholders have access to the same information?

Background: Under the Commission’s shareholder communications rules, beneficial owners generally are divided into two categories — non-objecting beneficial owners (NOBOs) and objecting beneficial owners (OBOs). NOBOs are so designated because they do not object to having their names and addresses released by bank and broker intermediaries to the issuers they have invested in, so the issuers can send them annual reports and other communications directly. OBOs are so designated because they object to having their names and addresses released by the bank and broker intermediaries. These beneficial owners, who are estimated to account for 75% of shares held in street name, may be contacted only by the broker or bank intermediary.

Issuers and other soliciting parties currently may request a list of NOBOs from the bank and broker intermediaries for a fee. The issuer or other soliciting party then may send the annual report and other communications directly to the NOBOs. The issuer may not, however, seek votes directly from these beneficial owners, as the broker or bank intermediary is the legal owner of shares that are held in street name for purposes of voting. Consequently, the proxy materials must be sent to the NOBOs through the broker or bank intermediary.

Some issuers have noted that, under the current system, their ability to communicate directly with beneficial owners who hold in street name is hampered inappropriately. In furtherance of this view, in 2004 the Business Roundtable (BRT) submitted a rulemaking petition to the Commission, requesting that it re-examine the shareholder communications system in light of technological and regulatory changes since the system was first adopted. One of the recommendations in the published BRT rulemaking petition is to eliminate the NOBO/OBO distinction and allow issuers to obtain lists of, and communicate directly with, all beneficial owners. Under the rulemaking petition, a beneficial owner who wished to retain its anonymity would be able to do so (e.g., by appointing a nominee), but would be required to bear the associated cost of requiring the issuer to communicate with it indirectly through intermediaries. The BRT petition further recommends that the shareholder communications rules be amended to permit issuers to the use the beneficial owner list to send proxy materials directly to the beneficial owners, rather than going through the broker or bank intermediary.

Some commenters on the BRT rulemaking petition oppose changes to the current shareholder communications system and argue that, while complex, it works well. They note that beneficial owners have privacy interests that are best served by the NOBO/OBO system and that brokers and banks have strong interests as well in safeguarding their beneficial owner lists. In addition, these commenters express concern that the changes recommended by the BRT would give issuers inappropriate control over the voting process. In 2006, the NYSE Working Group completed a year-long review of the NYSE rules regulating the proxy process. In its final report and recommendations, the Working Group noted that the NYSE should support efforts to improve the ability of issuers to communicate with their beneficial owners and formed a subcommittee to consider improvements to the system. The report also included a general recommendation that the Commission review its rules governing shareholder communications, without providing suggestions for specific rule changes.



Modified: 05/23/2007